Pakistan Research

Fertilizer ⎜ Sector Update

Fertilizer March 25, 2009

Valuations attractive Overweight

We maintain our liking for Fauji Fertilizer Co (FFC) as a defensive stock, offering the highest
dividend yield and trading at lowest Cy09 PER of 7.1x in our fertilizer universe. While Engro
Chemical appears much more expensive on Cy09 PER of 16.4x, it still trades at a PEG (PE
to growth ratio) of 0.45x (using 2-year earnings CAGR of 37% from Cy09 till Cy11), making
it an appealing growth play. We believe that the full value of Engro’s diversification
ventures (Engro Foods and Engro Energy) would be unlocked when the conglomerate is
split up into different listed entities with shares in each proportionately allotted to existing
shareholders of Engro Chemical. We maintain ‘Neutral’ stance on Fauji Bin Qasim (FFBL)
since near-term earnings and dividend risk persists, and given the standalone (non-
integrated) nature of the company’s DAP business, long-term earnings growth remains
highly dependent upon international product and raw material prices. We have reduced
our risk-free rate and hence equity discount rate assumption by 100bp to 14% and
before-tax cost-of-debt by 300bp to 15% for calculation of WACC for Engro Chemical’s
existing fertilizer business. Our revised Dec-09 target prices are as follows: FFC: PKR 96
(Buy); Engro: PKR 200 (Buy); and FFBL: PKR 16 (Neutral).
Raza Khan Niazi
Fauji Fertilizer – Dec-09 target price: PKR 96 (Buy) +92(21) 5611 492 ℡

FFC’s single product (urea) business with no major expansion/diversification plans and low +92 (21) 5611 532
net debt level lend relatively higher stability and visibility to its earnings/dividends. Local raza.khan@invisorsec.com 
urea price remains at a 45% discount to its international counterpart. At the same time, www.invisorsec.com 
the company offers exposure to the risks and rewards of the DAP business through its 51%-
owned subsidiary, Fauji Bin Qasim. We have assumed a dividend of PKR 3.40/share from
FFBL in Cy09, out of which PKR 2.25/share (declared in 4qCy08) will be received by FFC in
the 1qCy09. Chart–1: FFC relative price performance
130 KSE-100 FFC
Year to Dec Cy06 Cy07 Cy08 Cy09e Cy10e Cy11e
110
EPS-recurring 7.52 8.69 10.58 11.80 13.01 14.07
90
EPS-reported 7.52 8.69 10.58 11.80 13.01 14.07
70
DPS 8.00 8.80 11.00 11.80 13.00 14.10
50
EPS growth -5.3% 15.6% 21.7% 11.5% 10.2% 8.2%
30
PER 11.2 9.7 8.0 7.1 6.5 6.0
10
Div Yield 9.5% 10.5% 13.1% 14.0% 15.5% 16.8%
Mar-08

Apr-08

May-08

Jul-08

Aug-08

Sep-08

Dec-08

Jan-09
Oct-08
Jun-08

Nov-08

Feb-09

Mar-09
EV/EBITDA 6.2 5.6 4.6 4.2 3.9 3.8
P/BV 3.2 3.3 3.4 3.4 3.4 3.4

Engro Chemical – Dec-09 target: PKR 200 (Buy)

Engro Chemical’s various expansion and diversification projects remain on track for
completion: 1.3mtpa urea expansion by mid-Cy10, Engro Energy (220MW) by Dec-09,
Engro Polymer’s backward integration by mid-Cy09 and launch of ice cream by Engro
Foods in April ’09. Urea expansion, however, has faced significant cost escalation due to
rapid PKR depreciation and rise in domestic interest rates last year. However, given the
relative stability achieved in PKR/USD parity and falling domestic interest rates, we expect
business conditions to alleviate going forward. Furthermore, we believe that true value of
Engro’s subsidiaries (Foods and Energy) would be unlocked when these entities are listed
and shares in these entities are proportionately allotted to existing shareholders of Engro

See last page for Analyst Certification and other important disclosures
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should be aware that Invisor may have a conflict of interest that could affect the objectivity of this report. Investors should consider
this report as only a single factor in making their investment decision.
March 25, 2009 Fertilizer

Chemical. Using 2-year expected earnings CAGR of 37% (from Cy09 till Cy11) and Cy09
PER of 16.4x, Engro is trading PEG of 0.45x. Besides reducing risk free-rate assumption by
100bp to 14%, we have also reduced before-tax cost of new debt by 300bp to 15% for
calculation of WACC, which has reduced from 17.3% to 15.9%. Resultantly, our Dec-09
target (adjusted for right issue) has increased from PKR 165 to PKR 200.

Chart–2: Engro relative performance

Year to Dec Cy06 Cy07 Cy08 Cy09e Cy10e Cy11e
130 KSE-100 ENGRO
EPS-recurring 8.55 10.59 14.23 8.16 11.92 15.24
110
EPS-reported 8.55 10.59 14.23 8.16 11.92 15.24
90
DPS 5.08 4.55 4.29 2.86 3.00 4.60
70
EPS growth 10% 24% 34% -43% 46% 28%
50
PER 15.7 12.7 9.4 16.4 11.3 8.8
30
Div Yield 3.8% 3.4% 3.2% 2.1% 2.2% 3.4%
EV/EBITDA 9.0 10.5 9.4 14.7 14.3 5.1 10

Aug-08
Apr-08

May-08

Jul-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Mar-09
Mar-08

Jun-08

Feb-09
P/BV 2.55 1.68 1.24 1.49 1.36 1.23

Fauji Fertilizer Bin Qasim – Dec-09 target: PKR 16 (Neutral)

Full-year earnings remain highly skewed toward the final quarter which accounts for 50%
of annual DAP offtake. Moreover, quarterly price revisions of raw material phosphoric
acid reduce earnings/dividends visibility. FFBL has abandoned its plan to invest PKR
1,500mn (50% equity) in Foundation Power Co (175MW power plant) which we had earlier
assumed to be funded through debt and to contribute ~PKR 400mn dividend income
from Cy10 onwards. While subtracting the earlier estimated value-addition from the
power project from the valuation more than offsets the positive impact of 100bp
reduction in risk-free rate, our revised Dec-09 target for FFBL is PKR 16.

Chart–3: FFBL relative performance

Year to Dec Cy06 Cy07 Cy08 Cy09e Cy10e Cy11e
130 KSE-100 FFBL
EPS-recurring 2.13 2.30 2.69 1.99 3.48 3.53
110
EPS-reported 2.62 2.72 3.11 1.99 3.48 3.53
90
DPS 2.50 2.50 2.85 1.80 3.20 3.20
70
EPS growth -0.2% 8.0% 16.8% -25.9% 74.6% 1.5%
50
PER 6.6 6.4 5.6 8.7 5.0 4.9
30
Div Yield 14.4% 14.4% 16.4% 10.4% 18.4% 18.4%
EV/EBITDA 5.5 5.6 4.5 3.3 2.5 2.4 10
Aug-08

Oct-08

Nov-08

Mar-09
Mar-08

Apr-08

Jul-08
May-08

Jun-08

Sep-08

Dec-08

Jan-09

Feb-09
P/BV 1.90 1.91 1.55 1.52 1.49 1.45

INVISOR SECURITIES PVT. LTD. 2

March 25, 2009 Fertilizer

Analyst Certification
The research analyst(s), Raza Khan Niazi, for this report certifies that: (a) all of the views expressed
in this report accurately reflect his personal views about any and all of the subject securities or
issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or
indirectly related to the specific recommendations or views expressed by the research analyst(s) in
this report.

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