Blue-chip woes: Was Enven a strategic mistake?

The market seems jittery about Engro’s $1.1b bet on expanding its fertiliser business.

KARACHI:

Did Engro Corporation, one of the most admired conglomerates in Pakistan, make a strategic mistake by investing $1.1 billion in the world’s largest single-train urea manufacturing facility in the midst of a severe shortage of natural gas in the country? The market seems to think so, and even the company’s top management is willing to admit that it may not have been the best idea.

The scepticism about Engro’s strategic vision is a new one to the market, especially since the company had been described, in the words of the CEO of one asset management company, as “a blue-chip growth stock” – a company that could do no wrong in the eyes of its investors.

While there have been concerns about Engro’s leverage ratios (level of debt the company has taken on), none of the analysts who spoke to The Express Tribune mentioned any real fears of the company defaulting on its debts. Indeed, Engro has already completed its first Rs4 billion retail bond offering successfully and appears to be on track to complete a second bond offering directly to retail investors.

Yet equity investors are very nervous. Engro’s stock began the year well, climbing to a high of Rs237.19 on March 9, before plummeting an astonishing 31.5% to close at Rs162.46 on June 22 in trading on the Karachi Stock Exchange. Institutional investors, including Allied Bank Limited and ABL Asset Management, have been dumping their stock onto the market, according to people familiar with the matter.

The drop has come despite the fact that most market analysts expect the company’s 2011 earnings to exceed its 2010 net income.

The key worry, according to both the company’s management and investors, is that the firm will not be able to grow its bottom line as fast as had previously been hoped since Engro’s new fertiliser plant – known in company parlance as Enven – is not getting the 100 million cubic feet per day of natural gas that it needs to function at full capacity.

The plant itself is an engineering feat, larger and more efficient than any other in the country. Yet it needs the full supply of gas in order to function at maximum efficiency levels. It is currently receiving 80% of the total gas it needs, despite the fact that Engro paid a hefty fee to obtain a sovereign guarantee for the supply of gas from the government of Pakistan.

If the plant is viewed purely through the prism of Engro’s competition with its fertiliser rivals – Fauji Fertiliser and Fauji Fertiliser Bin Qasim – the plant makes a lot of sense. Allowed to function at full capacity, it would allow Engro to almost double its market share in urea from its current 20%.

Yet, despite the sovereign guarantees, the steady supply has remained elusive, despite the fact that the plant is located in Sindh, the province that produces 70% of the country’s natural gas and has the right of first usage on it. Engro’s plant, however, is supplied by Sui Northern Gas Pipelines Limited, the company whose clientele includes Punjab and Khyber-Pakhtunkhwa, the parts of the country with the most severe gas shortage.

The company held its first quarter analyst briefing on Friday at its Karachi head office, where it laid out the case for why Engro’s $1.1 billion bet on fertilisers still makes sense. Despite being a conglomerate with seven distinct lines of business, the company’s top management spent much of the time talking about their fertiliser subsidiary, and included a separate presentation on just Enven.

The case they laid out for why the company will still be able to grow its bottom line was persuasive, but company officials seemed to recognise the fact that investing in fertilisers at a time when the shortage of natural gas seemed more acute than ever before was probably not the right approach, though they refrained from calling it a mistake.

“Mistake would be a strong word,” said Engro’s chief financial officer Rohail Muhammad. “But we would not erect this huge fertiliser plant in today’s scenario.”

Nevertheless, the market’s jitters have caused the company’s leading shareholders, the Dawood Group, to begin buying out more shares in Engro as a signal to the market of their confidence in the company, according to people familiar with the matter. Engro’s management, however, appeared unaware of any such developments though they did not deny them either.

“I do not know if the Dawood Group is buying more shares. They are major shareholders of ours and they can buy shares if they see the situation is suitable to them,” said Muhammad.

Through its subsidiary, Dawood Hercules, the Dawood Group owns over 38% of Engro Corporation. The family’s patriarch, Hussain Dawood, serves on Engro’s board of directors as chairman.

 

Published in The Express Tribune, June 28^th, 2011.