The fertilizer industry in Pakistan is expected to see an 18% year-over-year increase in profitability in the third quarter of 2016 driven by higher urea and DAP offtake. However, this growth is boosted by abnormally low offtake in the third quarter of 2015 and the implementation of subsidies in June 2016. Inventories of urea are expected to remain elevated through 2018 as production continues to outpace demand despite recovery in offtake post budget incentives. The outlook for profitability in the fertilizer sector remains challenging due to structural issues like rising inventory levels and pressure on margins from price discounts, despite short term boost from subsidy measures.

1. Pakistan Fertilizers
Result Preview 24th October, 2016
BRP – 116
www.jamapunji.pk
Figure 1 –Market share 9M
Urea Market Share
9MCY16 9MCY15
FFC 46% 43%
EFERT 29% 32%
FFBL 10% 4%
Fatima 6% 7%
DHFL 3% 0%
AGL 5% 1%
NFML 0% 12%
DAP Market Share
FFC 5% 3%
EFERT 26% 26%
FFBL 34% 54%
Other 35% 17%
Source: NFDC, Next Research
Aijaz Siddique
+92-21-111-639-825 Ext: 109
aijaz.siddique@nextcapital.com.pk
Figure 2 – Fertilizer off-take in 3QCY16 was high on account of subsidy implementation
UREA
K tons 3QCY16 3QCY15 YoY 2QCY16 QoQ 9MCY16 9MCY15 YoY
FFC 692 476 45% 584 19% 1633 1696 -4%
EFERT 512 331 55% 242 111% 1040 1265 -18%
FFBL 181 75 141% 120 51% 336 169 98%
Fatima 141 59 139% 25 NM 215 272 -21%
DHFL 86 6 NM 28 203% 116 13 NM
AGL 96 21 NM 54 76% 177 28 NM
NFML 0 91 -100% 0 -58% 14 484 -97%
Total 1,708 1,059 61% 1,054 62% 3,531 3,926 -10%
DAP Offtake
K tons 3QCY16 3QCY15 YoY 2QCY16 QoQ 9MCY16 9MCY15 YoY
FFC 17 2 NM 15 9% 46 16 194%
EFERT 112 32 251% 63 77% 234 151 55%
FFBL 138 75 84% 96 44% 305 317 -4%
Other 146 14 NM 80 84% 317 101 214%
Total 414 122 239% 254 63% 902 584 54%
Source: NFDC, Next Research
Figure 3 – Next Fertilizer universe expected to post 18% YoY jump in profitability
EPS 3QCY16E 3QCY15 YoY 2QCY16 QoQ 9MCY16E 9MCY15 YoY
FFC 2.59 2.89 -11% 1.71 51% 6.43 9.39 -31%
EFERT 2.43 2.10 16% 0.51 376% 4.53 7.44 -39%
FFBL 0.26 0.19 33% -0.41 n.a. -0.7 1.01 n.a
Fatima 0.88 0.29 201% 0.88 - 2.29 3.55 -35%
Source: Next Research
Low base effect flatters to deceive; reiterate Underperform
 We expect the profitability of Pak fertilizer universe to rise by 18% YoY in 3QCY16.
Abnormally depressed off-take in the same period last year, coupled with the implementation
of subsidies from Jun-16, is the prime reason for the growth.
 Urea off-take is expected to clock-in at 1.7mn tons during 3QCY16 (+61% YoY), taking
cumulative 9MCY16 figure to 3.53mn tons, down 10% YoY. DAP off-take increased
significantly during 3QCY16 to clock in at 414k tons, up 239% YoY. Private imports
captured significant market share due to their competitive prices.
 Urea inventory is likely to remain elevated from CY16-CY18, as production continues to
outpace demand, owing to better gas availability. The possibility of exports to clear out the
inventory hinges on government’s ability to allocate a subsidy to cover transportation cost.
 We reiterate our U/P rating for the sector. However, we continue to highlight EFERT as a
lucrative dividend yield play given growing dividends and the steep underperformance in the
last 6mths.
Fertilizer universe profitability driven by higher urea and DAP off-take
Next Fertilizer universe is expected to post 18% YoY profitability jump in 3QCY16. While off-take in
3QCY16 was boosted by subsidy implementation post budget, the abnormally low offtake in 3QCY15
is also the reason for the growth. Gross margins are expected to fall as a result of PKR 50/bag cut in
urea prices absorbed by local manufacturers and incremental price discounts. Moreover, rising
inventory levels are expected to push up the industry’s finance costs up by 15% YoY.
Incentives priced-in; fundamentals to remain weak
We reiterate our U/P stance on the fertilizer sector; where structural dynamics remain challenging,
despite off-take recovering to some extent post budget relief measures. Our investment thesis hinges on
an average 3yr EPS CAGR of -6.8% for manufacturers through 2015-18E with longer than earlier
expected period of escalated inventory levels with increase in demand in CY17-18 not enough to
absorb the increase in local production. Moreover, subdued margins amid price discounts will keep
margins under pressure. We maintain our Underperform stance on FFC and FATIMA. We have a Buy

2. 2
stance on EFERT due to its growing dividend stream which translates into CY17E dividend yield of
13%. Furthermore, the company trades at CY17E EV/EBITDA of 4.5x compared to the peer average of
~7.0x. FFBL is currently under review.
Inventory unlikely to whittle down anytime soon…
As per our estimates, production is likely to outpace demand in CY17-18 as well, thus we expect
inventory levels to remain inflated through 2016-18E. Improved gas supply has resulted in a 15% jump
in industry production (primarily from FFBL/DHFL/AGL operating at increased capacity in CY16 due
to better gas availability) and we expect this trend to continue going forward. We expect FFC, EFERT,
FATIMA and FFBL to hold an average inventory of 340k, 380k, 260k and 50k tons, respectively,
through 2016-18.
…unless government grants export facility
As per our channel checks the fertilizer industry is pushing government to allow urea exports.
Government’s decision would depend on several factors such as the amount of subsidy to be allocated
to manufacturers to cover the transportation costs, if any, and the export quotas for the manufacturers.
However, even if govt. allows for export, excess supply in regional countries makes us skeptical that
the inventory will immediately clear out. Assuming (1) subsidization of transportation costs by the
government, (2) US$ 200/ton international urea prices, and (3) FFC/EFERT/FFBL/FATIMA allowed
350k/250k/75k/50k tons; EPS for our universe is expected to witness a 6-9% jump in CY17E earnings.
Figure 4 – Production likely to outpace demand over the next two years as well
Figure 5 – EPS sensitivity to urea exports prices suggest 6-
9% upside to our estimates for CY17E
Sales(ktons)
Price US$/MT
170 200 230
FFC - 350 0.14 0.83 1.51
EFERT - 250 0.21 0.62 1.04
FFBL - 75 0.02 0.19 0.36
Fatima - 50 0.14 0.19 0.24
Source: Next Research
Source: NFDC, Next Research
4.0
4.5
5.0
5.5
6.0
6.5
7.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Production (mn tons) Consumption

3. 3
Figure 6 – FFC expected to post 11% drop in EPS due to lower retention prices and other income
FFC: 9MCY16 Financial Summary
PKR mn 3QCY16E 3QCY15 YoY 9MCY16E 9MCY15 YoY
Sales 19,155 15,108 27% 47,476 54,294 -13%
Cost of Sales 13,469 9,156 47% 33,464 33,660 -1%
Gross Profit 5,686 5,952 -4% 14,013 20,634 -32%
Gross Margins 30% 39% 30% 38%
EBIT 5,676 5,118 11% 14,384 18,383 -22%
Finance cost 868 520 67% 2,046 963 113%
EBT 4,808 4,598 5% 12,338 17,420 -29%
Taxation 1,516 918 65% 4,153 5,474 -24%
Net Profit 3,292 3,680 -11% 8,185 11,946 -31%
EPS 2.59 2.89 6.43 9.39
DPS 2.50 2.75 -9% 5.90 8.44 -30%
Source: Next Research
Figure 7 – Higher volumes are expected to boost the profitability of EFERT
EFERT: 9MCY16 Financial Summary
PKR mn 3QCY16E 3QCY15 YoY 9MCY16E 9MCY15 YoY
Sales 19,031 13,869 37% 42,023 51,928 -19%
Cost of Sales 14,048 7,256 94% 29,742 31,225 -5%
Gross Profit 4,983 6,613 -25% 12,281 20,703 -41%
Gross Margin 26% 48% 29% 40%
EBIT 5,600 5,250 7% 11,639 17,172 -32%
Finance cost 849 1,164 -27% 2,412 3,560 -32%
EBT 4,751 4,087 16% 9,226 13,612 -32%
Taxation 1,520 1,298 17% 3,202 3,707 -14%
Net Profit 3,231 2,789 16% 6,024 9,905 -39%
EPS 2.43 2.10 4.53 7.44
DPS 2.00 1.50 33% 4.00 3.00 33%
Source: Next Research
Fauji Fertilizer Company Ltd (FFC): FFC is scheduled to announce its result on 26 October, 2016.
We expect the company to post PAT of PKR 3.29bn (EPS of PKR 2.59) in 3QCY16. Despite off-take
increasing 45% YoY, lower retention prices and higher fuel gas tariffs are expected to drag the bottom-
line. Dividend income, which was above PKR 1bn in 3QCY15, is expected to remain very low due to
lack of dividends from major holdings such as AKBL and FFBL. On the other hand, finance cost would
be higher as ST debt piles up following inventory backlog. We expect the company to announce a cash
dividend of PKR 2.50/sh, taking 9MCY16 payout to 5.90/sh.
Engro Fertilizer Limited (EFERT): We expect EFERT to post PAT of PKR 3,231mn (EPS: PKR
2.43) in 3QCY16, up 16% YoY. Improved urea and DAP off-take, up 55% and 251% YoY,
respectively is the prime reason behind the 37% YoY jump in revenue. Contrary to the sector, finance
cost for EFERT is expected to witness a 27% YoY dip with continued deleveraging outpacing the
growth in finance costs due to increased working capital requirements. We expect the company to
declare a cash dividend of PKR 2.00/sh.

4. 4
Figure 9 – Steep price discount drive volumetric growth and profitability of Fatima
Fatima: 9MCY16 Financial Summary
PKR mn 3QCY16E 3QCY15 YoY 9MCY16E 9MCY15 YoY
Sales 8,256 3,007 175% 21,032 21,807 -4%
Cost of Sales 4,419 1,060 317% 10,863 8,450 29%
Gross Profit 3,838 1,947 97% 10,168 13,357 -24%
Gross Margins 46% 65% 48% 61%
EBIT 3,529 1,410 150% 8,419 10,964 -23%
Finance cost 824 516 60% 2,124 1,786 19%
EBT 2,705 894 203% 6,295 9,178 -31%
Taxation 866 282 207% 1,480 1,725 -14%
Net Profit 1,840 612 201% 4,815 7,453 -35%
EPS 0.88 0.29 2.29 3.55
DPS - n.a 1.25 - n.a
Source: Next Research
Figure 8 – Earnings to turn positive on the back of higher sales
FFBL: 9MCY16 Financial Summary
PKR mn 3QCY16E 3QCY15 YoY 9MCY16E 9MCY15 YoY
Sales 10,786 7,057 53% 22,660 25,051 -10%
Cost of Sales 9,416 5,473 72% 21,626 20,563 5%
Gross Profit 1,370 1,584 -13% 1,034 4,488 -77%
Gross Margins 13% 22% 5% 18%
EBIT 1,029 772 33% 836 2,275 -63%
Finance cost 675 580 16% 1,627 1,420 15%
EBT 355 192 85% (791) 855 -193%
Taxation 114 11 NM (137) (84) 63%
Net Profit 241 181 33% (654) 939 -170%
EPS 0.26 0.19 (0.70) 1.01
DPS - - - 0.75
Source: Next Research
Fauji Fertilizer Bin Qasim (FFBL): FFBL is expected to post PAT of PKR 241mn (EPS: PKR 0.26)
in 3QCY16. Even though volumetric growth was impressive during the quarter with urea and DAP
sales up by 141% and 84% YoY, respectively, the business has suffered due to delayed revision in
phosphoric acid prices, coupled with rising inventories and lower retention prices for both urea and
DAP. In case of DAP, the company has failed to achieve the same sales growth as demonstrated by
private importers due to price competition. Phosphoric acid prices of FFBL have been revised to ~US$
600/mt. We have assumed US$ 650/mt and US$ 610/mt for 2Q and 3Q, respectively and used the
average cost method to calculate the cost of production in every quarter.
Fatima Fertilizer Limited (Fatima): We expect Fatima to post net earnings of PKR 1.84bn (EPS of
PKR 0.88) in 3QCY16, up 201% YoY. Whilst urea volumetric growth is strong, it is exaggerated by
the base effect due to unusually low off-take in 3QCY15. Moreover, FATIMA has been offering heavy
price discounts which are expected to put margins under pressure. CAN and NP also posted strong
growth figures. Moreover, working capital requirements are expected to hit FATIMA significantly with
a 60% jump in finance cost expected.

5. 5
APPENDIX 1
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Rating System
Next Capital Limited employs a three tier rating system depending upon sector’s proposed weight in
the portfolio as compared to sectors weight in KSE-100 index, as follows:
Rating Sector’s proposed weight in the portfolio
Over Weight > Weight in KSE 100 index
Market Weight = Weight in KSE 100 Index
Under Weight < Weight in KSE 100 Index
Ratings are updated regularly based on the latest developments in the economy/sector/company,
changes in stock prices, and changes in analyst’s assumptions.
Next Capital Limited employs a three tier rating system, depending upon expected total return (R) of
the stock, as follows:

6. 6
Where;

= Expected Dividend Yield + Expected
Capital Gain
 ‘R’ is before tax
 Investment horizon is between six
months to twelve months
Ratings are updated regularly based on the latest developments in the economy/sector/company,
changes in stock prices, and changes in analyst’s assumptions.
Valuation Methodology
The Research Analyst has used DCF (Discounted Cash Flow) methodology to arrive at Dec-16 Target
Price.
Key Risks
Margin attrition due to further decline in fertilizer prices
Rating Expected Total Return
Buy R ≥ 15%
Neutral 0% ≥ R < 15%
Sell R < 0%