View from McLeod Road: Why market’s bet on Engro Fertilizers is likely to fail

Published: June 23, 2013
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From a trough of Rs81.05 per share on January 16, the stock rallied to a peak of Rs151.95 on May 24. PHOTO: engrofertilizers.com

From a trough of Rs81.05 per share on January 16, the stock rallied to a peak of Rs151.95 on May 24. PHOTO: engrofertilizers.com

KARACHI: 

One of the biggest bets the market as a whole appears to be making in 2013 is that Engro is set for a comeback. The market is about to be proven wrong, and is likely to lose a lot of money doing so.

But first, a look at what has been happening to the company’s stock. Engro has always been one of the most respected companies in the country, and for good reason: it has a highly professional management, its major shareholders have a progressive attitude and its core business – Engro Fertilizers – was making a product that has a very high demand in Pakistan. What could possibly go wrong? A lot, apparently.

Engro’s business is based on some very shaky foundations: the promise of natural gas supply at absurdly low prices in a country that was rapidly ramping up domestic consumption and doing nothing to increase supply. It was a situation that could not last and it did not. For much of 2011 and 2012, Engro’s $1.1 billion manufacturing unit – the largest single-train urea factory in the world – was shut down owing to a lack of gas.

In 2013, there have been some rays of hope, with a little more gas supply, particularly to Engro’s older fertiliser plants, which have allowed the fertiliser business to more than triple its revenues in the first quarter to Rs9.7 billion, and swing to a quarterly profit of Rs646 million, from a loss of Rs1.4 billion in the corresponding period in the previous year.

This fact, combined with the election of Prime Minister Nawaz Sharif, has sent the market into a state of euphoria about Engro. From a trough of Rs81.05 per share on January 16, the stock rallied to a peak of Rs151.95 on May 24, soon after the election, a jump of over 87% in little over four months.

The problem, however, is that the market has been mistaking Sharif’s pledge to resolve the electricity crisis in Pakistan with an intention of somehow fixing all issues in Pakistan’s energy supply chain. The prime minister is indeed resolute in his desire to end power cuts in Pakistan. But doing so will require him to pick fights with a lot of very powerful vested interests. He has no intention of adding to that burden.

In order to resolve the electricity shortage in Pakistan, Sharif needs to get the state-owned power plants in Punjab up and running, and the only way the government will be able to afford to do that will be on coal or natural gas. Coal conversion will take time, so in the short run, they have to run on natural gas. The election has resolved at least one segment of the energy debate in Pakistan: the power sector is number one in terms of priorities for supply of natural gas.

The fertiliser manufacturers insist that there is still enough natural gas to supply them. In theory, they have a point, but in practise, the government would have to crack down on natural gas theft in upper Sindh and southern Punjab. Cutting theft will yield about 400 million cubic feet per day (mmcfd) of gas.

But, to put things in perspective, it took a highly motivated private sector management at the Karachi Electric Supply Company, operating in a much smaller geographic region, five years to cut electricity theft by one-third. How much gas theft reduction do we think a state-owned gas distribution company will be able to achieve in the next two years?

Some Engro investors argue that the government should supply gas only to Fatima Fertilizer and Engro Fertilizers’ new plant in Dharki, the only two in the country with still-valid sovereign guarantee of natural gas supply and cut it off for the rest. That, however, would involve cutting off the supply for the military-owned Fauji Fertilizer Company. The prime minister has plenty of fights already that he plans on picking with the military. Do investors seriously think he is going to waste his political capital fighting one of those fights over a fertiliser plant?

Which brings me to my final point about why the market is misinterpreting political conditions: the ruling Pakistan Muslim League Nawaz (PML-N) is an urban party. They have never focused on agriculture and their core constituency are not farmers. And lest anyone think that Engro can hold its investment in Thar coal hostage until the government gives it gas, think again: imported coal works just fine for the PML-N energy policy, and Thar coalfields are owned by the Sindh government, run by the rival Pakistan Peoples Party.

So ramping up local supplies of natural gas to Engro Fertilizers in the next two years is looking unlikely and the company’s plans to import liquefied natural gas are not making much progress so far. For the moment, the Engro Fertilizers comeback is looking very unlikely. In the long run, the company is likely to solve its natural gas shortage. But the time horizon on that is uncertain, and certainly does not justify a stock price increase this year.

Published in The Express Tribune, June 23rd, 2013.

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Reader Comments (6)

  • Zia Banday
    Jun 23, 2013 - 9:21AM

    Excellent take on Engro. I appreciate this political economy approach by the author to analyze the ground realities in business, which is rather rare in Pakistani journalism. Question remains unanswered is about the rationale of providing subsidized gas supplies to any sector….

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  • ouulman
    Jun 23, 2013 - 3:36PM

    It seems the author doesn’t care much about checking facts.
    There was no elections rally in ENGRO, neither was there any bulllish sentiment in engro due to PML-N’s election. In fact, engro under-performed the market during the said period

    http://goo.gl/aRYnp

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  • Patriot
    Jun 23, 2013 - 5:18PM

    Engro was fully aware of the fact that gas would not be available for its $ 1.1 Billion plant and was clearly so informed in a meeting at the PM house in 2006. However, they went ahead with building the plant and suffered a Rs 320 million loss in 2011 as gas was only available for about six months of the year. Their highly professional management could not understand the fact that you can’t have something that doesn’t exist. They were advised to base the fertilizer plant on Thar coal which would provide them practically unlimited raw material for decades but they wanted the easy way out. Remember that the first fertilizer plant in Pakistan, located at Daudkhel, was based on Makarwal coal.
    Nevertheless, there is a silver lining to all the wrong decisions made by them. According to the US Energy Information Administratio( EIA), Pakistan has 105 TCF of shale gas which would be sufficient for our needs, including Engro, for the next thirty years. The gas can be in the pipeline between three to five years time if the Government takes immediate steps for drilling the required wells on priority. The EIA also estimates that Pakistan has the 8th largest shale oil reserves in the world, 9 Billion barrels, sufficient to meet our requirements for the next 60 years. So, there will be sufficient gas and no oil imports if the Government can get experienced shale drilling contractors to start work with NLC providing the massive logistics required. The operation of these fields should be left to Pakistani companies such as PPL after discovery and drilling so that the price of gas and oil is NOT pegged to the price of imported oil. This will guarantee low fuel prices and help to rapidly increase GDP growth.

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  • Zeeshan
    Jun 23, 2013 - 9:51PM

    This is a market syndrome to rally on the sentiments and expectations. If you just look at the FFC which is giving DY of 14% on average over the last few years. And then see the price of the scrip is hovering between 107 to 121 which does not reflect the true worth of this scrip. FFC receives Gas from Mari Field which is owned by Fauji Foundation. So please forget about any suspension to FFC.

    The article has provided a very good and simple way of looking at the market and yet proves that stock market fluctuates based on baseless things. We must watch our investments.

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  • JS
    Jun 24, 2013 - 12:30PM

    What doesn’t make sense to me, and this issue was raised by Engro itself, is that both Fatima and Enven plants were set-up under the same Fertilizer Policy 2004. Yet government commitments made to Engro are not honored but commitments made to Fatima are fully honored, citing the inability of the govt to default on its obligations?!?
    I guess this wonky argument could only ever work in a country like Pakistan

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  • Patriot
    Jun 24, 2013 - 3:59PM

    SNGPL had made it clear to Engro that additional gas was not available for meeting the requirements of their new plant. Engro was able to use its influence with GOP to get 100MMCFD of gas sanctioned against the professional advice of SNGPL. There is no point in getting approval for a commodity which in fact does not exist. The gas shortage was expected to start in the summer of 2008 and WAPDA had been warned in the Pakistan Development Forum meeting held at Islamabad in 2003 that this would be the case and they should make alternative arrangements.
    The best option for Engro would have been to combine their proposed 1200 MW Engro Power plant and the fertilizer plant by setting up an IGCC complex in Thar where Syngas from coal could be supplied for both power generation and fertilizer production. They could also produce ultra low sulfur diesel from the same plant and optimize their profit. Their Sindh Engro Mining Company could increase coal mining capacity to meet the requirements of all three plants and also reduce costs due to economy of scale. What is more important is that their plant would have been operating at optimum capacity for decades. Their Management at the highest level was fully aware of these possibilities.
    There is no point in crying over spilt milk now.

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