Why Engro’s debt has been good for Fauji
Urea price increases, prompted by Engro, help its biggest rival more.
KARACHI:
After every earnings report, Fauji Fertilizer, and its subsidiary Fauji Fertilizer Bin Qasim, should send a thank-you note to the Engro Corporation: the latter’s decision to finance its expansion plan through leverage has resulted in an earnings bonanza for the Fauji group, and caused investors to flee from Engro.
The reason for this depends on a simple premise: Engro Corporation, according to its latest available balance sheet, has about Rs111 billion in both short and long term debt. By contrast, FFC and FFBL combined have a total debt of less than Rs17 billion. Needless to say, Engro’s interest payments are significantly higher, and the Fauji group’s payments much lower.
In order to ensure that it can pay off its debts in the midst of a severe shortage of natural gas (its raw material), Engro has continued to raise prices on its principal product: urea. Yet any additional revenue from price increases only translates to Engro meeting the interest and principal payments on its debts while the Fauji group – which matches those increases – sees that money trickle down straight to the bottom line.
This is why, when on Monday, when Engro announced a 25% increase in urea prices, Fauji Fertilizer stock was up 5%, the highest single-day jump allowed by the Karachi Stock Exchange. (Engro was also up 5% that day.)
The fertiliser market in Pakistan is essentially an oligopoly that the government allows to function, so long as they agree to consult with the government on price increases.
Nonetheless, given the shortage of urea in the country, the local manufacturers have considerable leeway, especially since imported urea costs about Rs2,340 per 50-kiogramme bag, about 18.2% higher than Engro’s recently announced price of Rs1,980 per 50-kilogramme bag. The government estimates that the total shortage of urea in Pakistan is around 1.2 million tons per year.
Yet despite the fact that it still has room to play in terms of the difference between local and imported urea prices, the market still does not like Engro. Its stock is down 27% for the year, despite healthy revenue and profit increases.
Nobody actually believes that Engro will default on its debts. The conglomerate is the first in Pakistan to raise money directly from retail investors, not just once but twice, through corporate bonds. So why dump its stock, and give up on its stellar growth?
Simply put, despite the fact that Engro is a conglomerate with seven distinct business lines, most investors still view the company primarily as a fertiliser manufacturer (it still derives 65% of its profits from the fertiliser business). If an investor wishes to profit from the rises in urea prices, it makes more sense to buy the stock of a company whose profits will rise faster. In this case, that company is Fauji Fertilizers (earnings almost doubled), not Engro (up 35%).
The comeback kid?
Engro, however, should not be counted out. While fertilisers may still be the largest business for the conglomerate, it also has a rapidly growing foods business that has consistently been gaining market share and is now profitable.
Engro’s new $1.1 billion urea manufacturing plant – the largest of its kind in the world – finally started contributing to the company’s revenue stream during the third quarter of 2011, causing a 35% jump in net income, despite the government’s inability to keep up its promise of an uninterrupted gas supply. In short, the company has a lot to offer.
“We still like the stock on account of pricing power in the fertiliser business and its fast growing foods business. We recommend a ‘Buy’ at current levels,” said Bilal Qamar, a research analyst at JS Global Capital, in a note issued to clients.
Published in The Express Tribune, November 2nd, 2011.
After every earnings report, Fauji Fertilizer, and its subsidiary Fauji Fertilizer Bin Qasim, should send a thank-you note to the Engro Corporation: the latter’s decision to finance its expansion plan through leverage has resulted in an earnings bonanza for the Fauji group, and caused investors to flee from Engro.
The reason for this depends on a simple premise: Engro Corporation, according to its latest available balance sheet, has about Rs111 billion in both short and long term debt. By contrast, FFC and FFBL combined have a total debt of less than Rs17 billion. Needless to say, Engro’s interest payments are significantly higher, and the Fauji group’s payments much lower.
In order to ensure that it can pay off its debts in the midst of a severe shortage of natural gas (its raw material), Engro has continued to raise prices on its principal product: urea. Yet any additional revenue from price increases only translates to Engro meeting the interest and principal payments on its debts while the Fauji group – which matches those increases – sees that money trickle down straight to the bottom line.
This is why, when on Monday, when Engro announced a 25% increase in urea prices, Fauji Fertilizer stock was up 5%, the highest single-day jump allowed by the Karachi Stock Exchange. (Engro was also up 5% that day.)
The fertiliser market in Pakistan is essentially an oligopoly that the government allows to function, so long as they agree to consult with the government on price increases.
Nonetheless, given the shortage of urea in the country, the local manufacturers have considerable leeway, especially since imported urea costs about Rs2,340 per 50-kiogramme bag, about 18.2% higher than Engro’s recently announced price of Rs1,980 per 50-kilogramme bag. The government estimates that the total shortage of urea in Pakistan is around 1.2 million tons per year.
Yet despite the fact that it still has room to play in terms of the difference between local and imported urea prices, the market still does not like Engro. Its stock is down 27% for the year, despite healthy revenue and profit increases.
Nobody actually believes that Engro will default on its debts. The conglomerate is the first in Pakistan to raise money directly from retail investors, not just once but twice, through corporate bonds. So why dump its stock, and give up on its stellar growth?
Simply put, despite the fact that Engro is a conglomerate with seven distinct business lines, most investors still view the company primarily as a fertiliser manufacturer (it still derives 65% of its profits from the fertiliser business). If an investor wishes to profit from the rises in urea prices, it makes more sense to buy the stock of a company whose profits will rise faster. In this case, that company is Fauji Fertilizers (earnings almost doubled), not Engro (up 35%).
The comeback kid?
Engro, however, should not be counted out. While fertilisers may still be the largest business for the conglomerate, it also has a rapidly growing foods business that has consistently been gaining market share and is now profitable.
Engro’s new $1.1 billion urea manufacturing plant – the largest of its kind in the world – finally started contributing to the company’s revenue stream during the third quarter of 2011, causing a 35% jump in net income, despite the government’s inability to keep up its promise of an uninterrupted gas supply. In short, the company has a lot to offer.
“We still like the stock on account of pricing power in the fertiliser business and its fast growing foods business. We recommend a ‘Buy’ at current levels,” said Bilal Qamar, a research analyst at JS Global Capital, in a note issued to clients.
Published in The Express Tribune, November 2nd, 2011.