BRIEF ANALYSIS OF INDUSTRY

FERTILIZER POLICY OF 1991

The salient features of that policy were:

Supply of feedstock gas at prices locked for 10 years

Guaranteed supply of gas for at least 9 months of the year.

Duty-free imports of the plant and machinery

Eight year tax holiday from date of commencement of commercial

production for new projects

No sales tax or excise duty on the sale of fertilizer

Expansion of existing plants to be allowed the same concessions as

new plants

No government sanctioning of private sector investment needed

Deregulation of prices of all fertilizers

If price controls are imposed by the government, prices are to be set

in such a manner that ex-factory prices guarantee a ROE of 20%

Duty-free import of phosphoric rock.

The Fertilizer Policy of 1991 proved to be very beneficial to not only the
fertilizer companies but also to the fertilizer industry as a whole. With a
major input material being subsidized, the fertilizer companies expanded
heavily. Engro Chemicals and FFC reacted by expanding their production
capacities and securing 10 years agreement (ending 2003) which
guarantee feed gas supply at concessional rates of Rs. 9.75/kilo cubic feet
(kcf). Engro also availed the tax holiday while FFC chose not to do so. In
1993, Engro set up a new plant to double its capacity to 600,000 tones and
FFC also got a new plant of 635,000 tons in 1992. This increased local
production reduced our costly imports and helped to develop this crucial
industry.

Local urea prices have increased by Rs1,126 per bag in the last five
years, while only 11% of this price increase was due to gas curtailment as
the government did not honor its supply contracts with fertilizer
manufacturers. The year 2010, 2011, 2012 and 2013 have been the
worst years for the fertilizer sector as instead of providing gas to local
plants, the government preferred to import urea by spending
approximately $2 billion.

In 2013 alone, the government spent $335 million on importing 968,000

tons of urea and also provided a subsidy of Rs17 billion.
Federal government announced to give subsidy of Rs. 20 billion on
Phosphatic / Potassic Fertilizers in the Federal Budget 2015-16.

Urea off-take, which represents roughly 73% in total fertilizer mix,

decreased heavily during Oct15 as compared to same period last year,
dropping from 408K tons in Oct14 to only 197K tons for Oct15. Whereas
DAP sales increased heavily by a very healthy margin of 65.4% from
corresponding period last year. However, on industry level, total fertilizers
off take inclusive of imports declined on MoM and YoY basis. All major
categories of fertilizer, are either excepting a decrease in prices, therefore
slowing their off-take; or are enjoying the tangible fruits of subsidies given
by the government, with increased off-take.

The budget was largely neutral for the Fertilizer sector

for the year 2015-16
Government has set a subsidy target for import of urea
at Rs25bn, 5% higher compared to last year.
Government has kept Rs145bn collection target under
the Gas Infrastructure Development Cess (GIDC).
The corporate tax rate has been cut to 32% from 33%.
3% Super Tax will be applicable on Fertilizers.
Minimum tax on fertilizer dealers has been increased
from 0.2% to 0.5%.
ENGRO: The budget affirms five-year tax holiday for LNG
terminal. Rice mills have been exempted from minimum
tax rate, which we believe will have an immaterial
earnings impact on ENGRO.
The government has announced a four-year tax
exemption for Halal meat production, which we believe
will bode well for FFBL.

The budget proved to be negative for the Fertilizer

sector for the year 2014-15
The Budget FY15 proved to be negative for the fertilizer
sector where the govt. has again set aside a huge
subsidy of Rs25bn for urea imports (while international
urea prices are at a low of ~US$315/ton FOB), compared
to Rs30bn allocated last year. This somewhat indicates
governments stance on the tradeoff between gas supply
to the fertilizer and power sector and can be taken as an
indication that the sector is unlikely to see an uptick in
gas supply during the short term. However, we have a
Market-weight stance on the fertilizer sector with
FATIMA (TP: Rs34) and ENGRO (TP: Rs235) as our top
picks.
The government made it clear that any future subsidy
scheme, whether electricity, gas, fertilizer, sugar and
wheat must be targeted at only the weaker segments of
the population. In this vein, the government has unveiled
plans to trim overall subsidies from Rs323bn in FY14E to
Rs203bn in FY15F.
Cess on gas consumers raised to a maximum of
Rs300/mmbtu: In the budget announcement,
government has replaced cess on gas with a maximum
cess of Rs300/mmbtu for any category of gas
consumers. The measure allows the federal government
to rationalize the cess rate on socio economic
considerations. It raises question marks over future cess
rates, particularly for Fertilizers and Cements.
Corporate tax reduced to 33%%: The reduction in
corporate tax rate by 1ppt is likely to result in enhanced
profitability for fertilizer sector companies as well, where

we may see an earnings impact on JS Fertilizer universe

companies by 1-2% on an annualized basis.

The budget proved to be negative for the Fertilizer

sector for the year 2013-14
With a huge subsidy of Rs30bn announced for urea
imports (while international urea prices are at a low of
~US$338/ton), we expect this measure to bode negative
for the fertilizer sector. To recall, last year, when urea
prices were trading above US$400/ton mark at
~US$434/ton, the amount set aside for urea subsidy was
lower at Rs26bn (and actual allocation was far lower at
Rs10bn despite ample import). This somewhat indicates
new governments stance on the tradeoff between gas
supply to the fertilizer and power sector and can be
taken as an indication that the sector is unlikely to see
an uptick in near-term gas supply.
Subsidy of Rs30bn for import of urea: Subsidy
target for FY14 for urea import has been increased to
Rs30bn. Given current international urea prices we
believe the government can import ~2mn tons of urea
with this urea subsidy target. With annual demand of
5.7mn tons of urea and domestic production of 4.2mn
tons, we anticipate an inventory pile up if the entire
amount is used to import urea. This is likely to hurt
pricing power of domestic urea players in our view.

GST hiked to 17%: The hike in GST by 1ppt is likely to

result in an incremental price rise of Rs14/bag and
Rs32/bag for urea and DAP respectively. We expect
fertilizer producers to fully pass-through the incremental
cost impact.

Imposition of GST on retail price: The new

government has imposed GST on retail prices instead of
ex-factory prices. This is likely to result in a hike of ~Rs5/
bag in urea prices to fully pass on the impact to end
consumers. Government has also added fertilizer to the
list of items that is required to print retail price and tax
thereon on product bags.

The budget proved to be negative for the fertilizer

sector for the year 2012-13
Budget FY13 was largely negative for the fertilizer sector
with the government announcing hike in GIDC gas rates.
GIDC on feed and fuel stock gas has been hiked by
PkR103/mmbtu and PkR87/mmbtu respectively, which
would raise urea manufacturing costs for old plants by
PkR138/bag. Furthermore, GOP has kept a urea import
subsidy target of PkR26bn, providing cushion to import
more urea in case there are supply shortages (gas
curtailment), besides the subsidy could also be used to
moderate the urea prices. While FFC yesterday raised
urea prices by PkR50/bag, we believe that the real test
would come in Jul12 when new gas prices would come
into effect, where we are likely to see a less than full
pass-through of GIDC.
GIDC rate further hiked: GIDC on feed stock and fuel
stock has been increased by PkR103/mmbtu and
PkR87/mmbtu, respectively, translating into an average
PKR138/bag rise in urea manufacturing cost. This has
added another negative to the recent list of adverse
developments for the fertilizer sector. FFC is most
affected by this development, followed by ENGRO and
FFBL. FATIMA is least affected by this rise, as feedstock

cost (along with ENGROs new plant) is locked in for first

10yrs of operations. Rise in GIDC will dent the
annualized EPS of FFC, FFBL, ENGRO and FATIMA by
PkR3.65, PkR1.09, PkR2.85 and PkR0.11 in case of zero
pass through. Going forward, ability of fertilizer
manufacturers to pass on the impact of GIDC will hold
the key to their profitability and price performance.
Urea import subsidy set at PkR26bn: With budget
subsidy allocation of PkR26bn for urea imports, ~1.2M
tons of urea can be imported assuming landed urea price
of US$525/ton and current NFML urea price of
PkR1,600/bag (ex-GST PkR1,379/bag).With a likely return
to the fold of the IMF, reduction in subsidies would help
in restoring pricing power of local urea manufacturers.
However, in the near term the threat of further imports
exists, where the recent sell-off in commodities may
further enhance the GoPs bargaining power (regional
urea prices down by ~US$30-40/ton WoW).
FFC makes its first move, urea prices raised by
PkR50/bag: Our channel checks indicate that May12
industry urea sales rebounded sharply following the
reduction in urea prices by PkR145/bag last month, with
the sales revival headed by FFC. With some liquidation of
inventory and expectation of robust sales in Jun12 (on
anticipation of urea price hike in Jul12), FFC has raised
urea prices by PkR50/bag (ex-GST PkR43/bag) to
PkR1,700/bag. Other industry players are also expected
to mimic FFCs move but the real test would come in
Jul12, when gas rates are revised.
Considering the what ifs of GIDC: Below we have
provided a scenario analysis for our fertilizer universe
companies. For our worst case scenario, we have
assumed zero pass through of GIDC, which we view as

highly unlikely. For our most likely scenario, we have

assumed a urea price hike of PkR95/bag, which would
restore urea prices to their pre-price cut levels of
PkR1,795/bag. For our best case, we have assumed a
urea price hike of PkR255/bag after taking into account
the full GIDC pass through and price hike to fully cover
up the price cut in May12. Within our fertilizer universe
we retain our liking for FATIMA given its relative
insulation to the gas price hike; however FFCs earnings
are going to be most impacted in case there is less than
full pass-through of GIDC.

Pakistan is one of major exporter of fertilizer with one of the worlds biggest
fertilizer plant which is recently constructed. Our country being an
agricultural country, the consumption of fertilizer is a direct indicator of the
growth of the agricultural sector. Fertilizer Industry of Pakistan is extremely
fertile worldwide.

Over all industry capacity is approximately 7.5 million tons per annum;
there are six big name of fertilizer producer Engro crop, Fauji Fertilizer,
Fatima Fertilizer, Dawood, Hercules, ICI Pakistan and National Fertilizer
Corporation. Pakistan is one of the leading exporter of fertilizer urea after
fulfill the local demands Pakistan is in position to export all kind of
agrochemical and fertilizer and also started work on Rock phosphate mines
and ready to supply the demand of high grade of gypsum.
Pakistani urea is trusted as high grade fertilizer which is suitable for all
crops on all types of soils and an excellent source of nitrogen for the vast
majority of cultivated soils. Phosphate fertilizer is also good for all crops it is
an equally good source on problematic soils on overall basis, it suits about
90% soil of the country.

Urea is widely used in the country and this fertilizer is white in color, frees
flowing, soluble in water and contains nitrogen. Fertilizer Industry is a big
source of trade of Pakistan and also creator of employment, over 30
manpower working with the Industry and huge manpower is associated
with connected trading companies. There are six major companies and 14
factories which are producing fertilizer like: -Urea- ammonium phosphatecalcium ammonium nitrate-ammonium sulphate -nitro phosphate -sulphate
of potash calcium phosphate has a rapid as well as permanent effect.
In this particular Industry there is no local association in the country, the
country is the member of the International fertilizer association {IFA} the
{PTUDC} Pakistan trade union defense campaign which works for safe
guard the right of the workers.

To increase agriculture production and ensure food security, the

government has taken various measures to ensure availability of seed,
fertilizers and pesticides and other important ingredients.

On the basis of assessment of fertilizer situation by the Fertilizer Review

Committee, the fertilizer supplies are ensured through domestic production
and imports. There is sufficient fertilizer to cater the Rabi season
requirements. However, the government plans to imports 0.125 million tons
Urea fertilizer to stabilize the supplies for Kharif 2014 season.
The government has also well aware over the sale of spurious and
substandard agricultural inputs in the country and also takes appropriate
measures to discourage it.
Federal Seed Certification and Registration Department (FSC&RD) has
been instructed to monitor and regulate the sale of spurious and substandard seed in the market.
Fertilizer quality is monitored by the Provincial Agricultural Departments. In
line with the provision of the Pesticides Ordinance 1971 and Amendment
Act 1992 and 1997 pesticides inspectors from the provincial agriculture
departments are mobilized to keep vigilance on the pesticide shops and
warehouses of pesticide distributors to ensure quality of these products.
Pakistan would have to spend approximately Rs 452 billion annually on
urea imports if the government decided to close down the fertilizer industry
by permanently disconnecting gas from seven fertilizer plants with a
combined annual production capacity of 6.9 million tons.
The cost of importing 6.0 million tons of urea would be roughly Rs 312
billion while an additional Rs 140 billion would be needed to subsidize this
imported urea to match the prevailing urea prices. Fertilizer Manufacturers
Pakistan Advisory Council (FMPAC).