Agriculture constitutes the largest sector of our economy.

Majority of the population, directly or indirectly,

dependent on this sector. It contributes about 24 percent of Gross Domestic Product (GDP) and accounts for
half of employed labour force and is the largest source of foreign exchange earnings. It feeds whole rural
and urban population.(PSB)

IBEX Pakistan Fertilizer Sector: FFC

Demand for Urea and DAP (Dai Ammonium Phosphate), an essential crops nutrient, has greatly increased over the
last one year resulting in bouyancy in fertilizer scripts which outperformed the benchmark KSE100 index. The prices
of UREA have increased in recent time curtsy to new tax regulation and gas curtailment by govt. Price of UERA have
reached to approximately PKR 1,020. In the form of these price hikes, manufacturers have completely transferred the
tax cost to customers. With successful transfer of GST levy to customers along with high demand, urea sector looks
to be on sound footings for the coming year. Recent investments and initiatives in this sector are likely to reap strong
earning results in coming years. Major investment has been done by ENGRO in the form of its new plant, which is
expected to produce 1.3mn tones of urea. DAP on the other hand might face cut in its demand since its prices have
almost doubled over the last one year. Sharp price increase along with greater price difference between urea and
DAP may cause demand contraction in future unless some respite is provided by the government in the form of
increased wheat support prices (since DAP is a major input for wheat crop).

Fertilizer Sector shows growth and expansion opportunities, benefitting from an agrarian economy. Agrarian sector
almost contributes about 23% in overall GDP. Over the past decade government policies have also favored Fertilizer
sector providing them with the luxury of huge subsidies on gas bulk. The benefits however at times come with risks of
supply curtailment by government due to recent energy shortfall. This gas shortage reaches its peak normally during
three winter months, however over the last few years, this period was extended beyond the normal three month time.
Fertilizer companies were able to pass on the resultant expenses to end-consumers this time around but fears remain
as to how much price can be passed on to end-consumer in case of further increase in gas curtailment period.
International grain prices have also spiked over the last year. This increase in international prices is explained by
Heavy floods in Australia, drought conditions in Russia which caused a ban on its exports along with unrest in the
Middle East. Prices of Urea are likely to continue its upward trend because of the factors explained above. Domestic
prices of urea are still at a considerable discount from international prices, displaying a strong appetite for growth.
These strong fundamentals are however dependent on a crucial factor of gas supply.

Fauji Fertilizer Company remains the market leader in Fertilizer Industry and still remains strong in domestic market.
About 44% shares in FFC are owned by Fauji Foundation group. Fauji Fertilizer Company has its monopoly in the
province of Punjab, the hub of agricultural activities. FFC also holds 51% stake in Fauji Fertilizer Bin Qasim and
12.5% in Pak Maroc Phosphore. FFC has also filed a pre-merger application for 75-79 per cent shares of Agritech
Limited. FFC has also diversified its operation by taking up wind projects in Thatta/Sindh.

PKR(mn)
CY09 CY10 % growth CY10 CY09
36163 44874 24%
Net Sales Operating Ratio
Gross Profit 15684 19564 25% Gross Profit Margin 44% 43%
 3175 3944 24% 38% 38%
Distribution Cost EBITDA Margin
12474 15619 25% 25% 24%
Operating Profit Net Profit Margin
1272 1376 8%
Other Expenses Valuation Ratio
2801 3153 13% 13 13
Other Income Basic EPS
945 1087 15% 13 10.4
Finance Cost Diluted EPS
13057 16310 25% 12% 16.20%
Profit before Tax Dividend Yield
8823 11029 25%
Proft after Tax Performance
10.4 13 25% 71% 67%
EPS ROE
26% 23%
ROA
Leverage
18% 19%
Debt to Equity
16% 15%
Interest coverage
Source :Standard Capital Securities(Pvt) Ltd

FFC is one of the most stable companies with strong cash flows, stable earnings, consistent dividend payouts and
low leverage. FFC is likely to remain stable benefitting from government subsidies, strong urea growth, domestic
market advantage and high prices gap between domestic and international markets. The recent gas curtailment will
also benefit FFC since it gets gas from Mari Gas network while other major fertilizer companies are based on the
SNGPL network which is increased span of gas curtailment.

FFC is likely to continue its steady growth along the lines of agriculture growth trends. Its likely acquisition of Agritech
and expansion in wind energy might create synergy benefits as well. The acquisition of Agritech will require debt
raising along with cuts in dividend payouts, however strong domestic demand for urea along with current low capex
business can reap higher dividends in subsequent years.

Prevailing domestic energy crisis is one of the major risks for FFC. Regular gas supply is also of great importance in
fertilizer companies operation and if the current gas curtailment reaches to a significant level then it might not be
possible for FFC to run its operations smoothly. Having said that, domestic economy highly relies on agriculture for its
food security, so there are good chances that the necessary measures will be taken to accommodate Fertilizer sector.
Another factor that needs to be taken into account is FFC exposure to foreign exchange rate risk in the form of a
substantial stake in Pak Maroc Phosphore Company which operates in Morocco and abroad.

CY 09 CY10 %change
64%
CFO 8,919,075 14,628,659
-180%
CFI (1,372,806) 1,101,352
84%
CFF (6,191,009) (11,421,711)

Recent economic meltdown along with financial stress might push government to withdraw some of its subsidy. In
that case, it would be difficult for FFC to maintain the same cash flows and earnings growth.
Penalty Case

The Competition Commission of Pakistan (CCP) jolted the fertilizer sector when they imposed a penalty of Rs
864 Crore (largest in Pakistan) on leading fertilizer manufacturing companies Engro Fertilizer Limited (EFL)
and Fauji Fertilizer Company Limited (FFC) for abuse of their dominant position through unreasonable

price increase.

2 Years Old Case finally Witnessed an End

The Commission took notice on its own of a price increase carried out by all the urea manufacturers in
Pakistan in December 2010 that continued through 2011.

The Commission constituted an Enquiry Committee to identify whether the subject price increases amounted
to a contravention of the provisions of the Competition Act, 2010. In this regard the Enquiry Report
concluded on 25th June 2012, carried out an analysis of factors such as gas curtailment, input costs, profit
margins, subsidies, government policies etc. to reach at the conclusion that the undertakings found to be
individually as well as collectively dominant, abused this position in carrying out unreasonable increase in
prices in violation of Clause (a), Subsection (3) of Section 3 of the Act.

All urea manufacturers were issued show cause notices (SCN) for individual and collective abuse of dominant
position.

The Bench comprising the Chairperson Ms Rahat Kaunain Hassan and senior member Abdul Ghaffar, in its
order, observed that in determining whether the undertakings were individually dominant in the urea market
(the relevant market) particularly with respect to the aspect of unreasonable price increase, it was
necessary to go one step ahead of establishing that the market was captive and determine on a case by
case basis whether each undertaking had the market power to effect, influence or initiate a price change in
the market.

Engro Fertilizer Started All This

In this regard Engro Fertilizers had itself demonstrated by being the price initiator, that it was in fact
dominant in the relevant market. With respect to Fauji Fertilizer Company it was thus found by the bench
that having a much greater market share in the relevant market in terms of production and satisfying the
test for market power provided for under Section 2(1)(e) of the Act, it was the only other undertaking in the
relevant market with the ability to initiate price changes in the relevant market other than Engro Fertlizers.
All the other undertakings were found by the bench to be lacking in the ability of being the agents of
unreasonable price increases in the relevant market and were therefore not found to be individually
dominant.

The bench took into consideration numerous factors including local concerns such as the nature of urea as
an essential commodity, its importance to the farmer and agricultural growth and the Government Of
Pakistan based subsidy provided to the undertakings and then employed numerous comparators (involving a
comparison of profitability with jurisdictions of similar nature) in the light of the test laid out in the other
developed jurisdictions.

Unusual Profits of Fauji and Engro

Fauji Fertilizer Company was found to have more than doubled its profits from around Rs 1,100 Crore in
2010 to Rs 2,250 Crore in 2011. Its ROE after tax of 97.5% was way above the ROE after tax enjoyed by
undertakings in agro based economies similar to Pakistan in all aspect of the Urea business (ROE after tax in
India having an upper ceiling of 12%).

In respect of Engro Fertilizer the bench observed in the light of a case of excessive pricing in Turkey that
plummeting profits or even a loss registered by an undertaking doesnt imply that it cannot abuse its
dominant position.

The Bench looked at the increase in gross profits as they neutralized the effect of its debt obligation that was
peculiar to it not just in terms of the fact that it carried out the investment but also in terms of the
arrangement it agreed upon with the lender/financers to pay it back.

Based on its findings and taking into account all relevant factors, including the product involved, its
significance for the economy and the quantum of subsidy availed by the Fauji Fertilizerand Engro Fertilizers
which amounted to Rs 1100 Crore and Rs 450 Crore respectively for the year 2011 only, the Bench imposed
a maximum penalty provided for under the Act on both EFL and FFC i.e. 10% of their individual turnover
(translating to sums of Rs 3.14b for Engro Fertilizer and Rs 550 Crore for Fauji Fertilizer) for each abusing its
dominant position in violation of the Act.

CCP Recommends Cost Audit to SECP

Furthermore the bench deemed it critical to advise Securities and Exchange Commission of Pakistan (SECP)
that forensic cost audits pertaining to all the undertakings must be carried out by independent auditors in
the interest of transparency and the information so obtained shared with the relevant departments of the
provincial and Federal Governments along with the Commission.

Lastly the bench was of the considered view that a mechanism needs to be evolved by the Government of
Pakistan so that the subsidy (if any) should be directed at the farmer who is the ultimate beneficiary of
subsidy as per the objective of fertilizer policy 2001 to ensure availability of Urea at an affordable price.
Govt spends Rs45bn on fertilizer subsidy
Thursday, 31 May 2012 18:20
Posted by Asad Naeem

ISLAMABAD: The government has spent

around Rs. 45 billion as fertilizer subsidy during the first nine months of current fiscal year 2011-12.

Due to the curtailment of natural gas some urea plants produced substantially less than their production capacity as a result 1.6
million tonnes of urea had to be imported by the government during 2011-12 to meet the deficit, said Economic Survey of Pakistan
2011-12 released here on Thursday.

At the beginning of 2011-12, it was assumed that the country will attain self-sufficiency at least in urea availability because of the
operationalizing of two new plants.

This has added annual production capacity of 1.8 million tonnes to the national installed capacity taking it to 6.3 million tonnes per
annum.

The fertilizer sector is the second largest consumer of gas after the power sector. Natural gas is used as feedstock as well as fuel in
the manufacturing of nitrogenous fertilizers.

Three companies namely Sui Northern Gas Pipeline Limited, Sui Southern Gas Company Limited and Mari Gas Company Limited
are providing gas to the fertilizer sector.

The policy of gas supply is adversely affecting domestic production of fertilizer and resulting in a price hike and increase in the
import bill.

Smooth supplies of natural gas to urea plants are essential to run the plants at 100 percent of their installed capacity for making
urea available (as per requirement) at stable/affordable prices and for avoiding its import.
Copyright APP (Associated Press of Pakistan), 2012

Urea sales slump 12% to 5.2m tonnes in 2012

Staff Report

KARACHI: The overall sales of urea producers have recorded at 5.2 million tonnes in 2012 versus 5.9 million tonnes
compared to last year, down by 12 percent due to higher high prices of local brands and limited production
restricted by gas curtailment.

The local urea manufacturers sales during 2012 sharply reduced to 4.2 million tonnes versus 4.8 million tonnes in
2011 primarily due to availability of low priced subsidised imported urea in the market and higher gas curtailment.

Company wise data shows Fauji Fertilizer Company (FFC) with highest market share sold 2.4 million tonnes of urea
in 2012, which is almost flat compared to last year.

Engro Fertilizer urea sale remained stood at 0.9 million tonnes of urea due to gas curtailment, which is down 28
percent if compared with previous year sales of 1.3 million tonnes in 2011.

The urea sales in December stood at around 940,000 tonnes, which is highest ever sales in the month of December
in last decade. This is primarily in anticipation of no decline in urea prices after Economic Coordination Committee
(ECC) decided not to allocate gas to fertilizer makers.

Thanks to sharp recovery in urea sales, the total inventory local and imported alike is estimated to fall to 430,000
tonnes at December-end which is lowest level in last 5-month.

The urea inventory with local manufacturers sharply plunged to around 40,000-50,000 tonnes, which was 518,000
tonnes in November 2012. Local manufacturers sold approximately 850, 000 tonnes of urea in December compared
to 308,000 tonnes in November 2012

The government on the other hand is holding imported urea inventory of around 400,000 tonnes in December
compared to 483,000 tonnes in November.

Thus the governments National Fertilizer Marketing Limited was able to sell only approximately 90,000 tonnes of
urea in December due to quality issues and thin price variation with local brands.

Company wise data showed FFC might have sold around 415,000 tonnes in December. This is followed by Engro,
which sold approximately 240,000 tonnes of urea in December.

Thus cumulatively during fourth quarter 2012, FFC sold approximately 780,000 tonnes of urea, up 64 percent QoQ
while Engro sold approximately 310 million tonnes during the same period, up 57 percent QoQ.

Fertilizer Sector: Investment case improves on likely stable

urea prices Elixir Research
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Fertilizer Sector: Investment case improves on likely stable urea prices Elixir Research

By: Sateesh Balani, Elixir Securities

sbalani@elixirsec.com

(+92-21) 3569 4679

Urea prices to sustain in CY13

We expect urea prices to sustain at current levels (PKR1,670/bag) during CY13 and do not foresee
possibility of the price cut on account of 1) lower imports, 2) higher crop prices and 3) allocation of
expensive gas to SNGPL based fertilizer plants. We have discussed these factors in todays research note.

Imports to be minimal during the year

Unlike CY12, we expect government would not import urea in large quantities during CY13. Imported urea
sales were more than 22% of total urea sold during CY12. Higher imports during CY12 were aimed at
keeping urea prices low to support farmers and cherish voters for elections of 2013. We believe this shall
not continue in CY13 and contribution of imports in overall urea sales would decline.

Higher crop prices to support off take; less needs for discounts

Fertilizer manufacturers realized lower urea prices during 4QCY12 as they gave discounts to encourage
urea sales. Weak market / administered crop prices amid higher urea prices significantly hurt urea
demand in CY12. Cotton prices have recently started rising while GoP has increased wheat support price
by 14%.

Expensive gas to SNGPL based plants further supports the case

Gas price under gas sales agreements (GSAs) of SNGPL based fertilizer plants with E&P companies would
likely equal well head prices of E&P companies and would be significantly higher than the existing
feedstock price of USD3.3/mmbtu. Cost of gas from KPD field, which comprise 60% of the total allocated
gas is expected to be USD5/mmbtu. With this expensive gas supplied to SNGPL based plants; the case of
urea price decline becomes weaker.

Upgrade stance on sector to Overweight; prefer ENGRO and FATIMA

Besides short term urea price stability, we now expect much smaller eventual urea price reductions, if any,
after full materialization of 202 mmcfd of gas supply to SNGPL based plants by mid 2014. We expect
fertilizer manufacturers to sustain current EBITDA margins. Reduction in risk of urea price decline makes
the investment theme attractive for fertilizer sector. We thus upgrade our stance on the sector to
Overweight. We prefer ENGRO and FATIMA at current levels as they offer total returns of 40% and 46%
respectively.

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Fertilizer Sector of Pakistan: Light at the end of tunnel

Research of the Week by Arif Habib Research
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Fertilizer sector of Pakistan: Light at the end of tunnel Research of the Week by Arif Habib Research

Research Team, Arif Habib Limited

Fertilizer sector set to rebound

Though an awful year for the fertilizer sector came to an end, clouds of uncertainties still roam around
the sector. Among key issues, with respect to the fertilizer sector, gas remains on top. Companies on the
SNGPLs network suffered the most, with complete gas shutdown for almost 290 days in CY12. Since a
long-term gas plan has been on the cards, for the plants operating on the SNGPL network, the new ray of
hope has eventually spelled out new soul into the fertilizer sector scrips once particulars of the long-term
plan were approved by the ECC.

Engro Corporation Limited the worst seems behind us

CY12 was a miserable year for Engro Corporation, as its fertilizer arm (Enven) only managed to operate
for 45 days during the entire year. This was the prime factor in dragging companys bottom-line by a heft
hefty 77% YoY in CY12. Silver lining appears on the horizon with the approval of long term gas plan, which
will enable ENGRO to operate both of its plants though at a higher gas price of PKR 426/mmbtu, expected
to be materialized by 2QCY14. Meanwhile, ENGRO is expected to receive gas from SNGPs network as and
when available on the agreed price of PKR 70/mmbtu. Assuming a 45 days gas availability of 76mmcfd,
we expect EFERT to post an EPS of PKR 2.38 (Impact on ENGRO: PKR 4.99/share) in CY13. The stock
offers 49% upside with SOTP Dec-13 PT of PKR 196/share; thus we recommend buy.

Fauji fertilizer Company Limited Safest bet in the fertilizer sector

FFC remained the biggest beneficiary in terms of gas curtailment to peers in CY12, thanks to Maris gas
network, which faced least gas curtailment (~12%-15%). FFC remained the market leader in urea sales, as
the company managed to cater 46% of total urea offtake with capacity utilization at 120%. We expect the
company to carry forward the same utilization level in CY13 with an estimated earnings PKR 15.49/share.
We also expect the companys new ventures i.e. significant stake in AKBL and power sector to yield long-
term support to earnings. FFC trades at 15% discount to our DCF based Dec-13 TP of PKR 124/share. In
addition, a massive CY13F DY of 14% puts icing on the cake. Buy FFC!

Fauji Fertilizer Bin Qasim Limited DAP margins on thriving mode

FFBLs plant remained shut on numerous occasions due to persistent gas curtailments during CY12. We
expect CY13 not to bring any major turnaround in terms of gas availability. However, strong recovery in
DAPs primary margins (12% YoY jump to USD 280/ton) coupled with the fact that DAP production
requires less gas (so low impact of gas curtailment on DAP production) is not only expected to mitigate
the impact of lower urea production due to gas curtailment but yield a healthy 46% YoY earnings growth
to PKR 6.66/share during CY13. Our DCF based Dec-13 target price for FFBL works out to PKR 45/share,
offering an upside potential of 21% with CY13F DY of 12%, so, we recommend Buy.